Royal Mail to lead retail revival for IPOs?

March 11 (IFR) - After being largely ignored by the IPO market for many years, UK retail investors are set to become an important piece of the puzzle once again.

Political considerations dictate that three large sales by the UK government - the sell-downs of Royal Mail Group GBPO.UL, Lloyds Banking Group (LLOY.L) and RBS (RBS.L) - will have to include retail, while bankers are keen to tap this price-insensitive investor base in order to put the IPO market back on its feet.

In fact, some companies coming to market have already started looking to retail buyers. In October, Direct Line included an intermediary offer - in which retail could subscribe through 29 brokers - in its £905.6m IPO.

Without any advertising, the deal attracted 25,000 retail orders (for £177m of the available stock). Fellow car insurer Esure is also tapping retail investors through intermediaries in its IPO, which began bookbuilding on Friday.

Both offers are a long way from the previous high-profile effort to attract British retail participation - the 2010 listing of Ocado (OCDO.L) - when the online retailer largely failed to convince customers to take part.

But conditions now are much more favourable. Low interest rates have severely depressed annuity rates, prodding cash-rich pensioners to look elsewhere to supplement their retirement incomes. And bankers are sniffing around the reservoir of retail money in the belief that state-sponsored offers will seduce investors who cannot find decent yield elsewhere.

"Compared with a decade ago, there is a colossal amount of money available," said Jim Renwick, chairman of ECM, EMEA at Barclays. "It is concentrated among the retired or nearly retired - people who have investible assets. There is around £500bn under administration by this segment of the market."

At the same time, the line-up of government assets to be sold is a perfect fit for the retail market, with yield set to be the driver for each transaction. Royal Mail's £1bn-plus IPO is due first. UBS UBSN.VX is advising the government, while Barclays, Bank of America Merrill Lynch and Goldman Sachs are working with the company.

The deal is expected later this year. Mobile phone operator EE, a joint venture of France Telecom FTE.PA and Deutsche Telekom (DTEGn.DE) is another yield-play looking to float late this year - although 2014 is more likely - that would benefit from the retail interest aroused by Royal Mail.

Of course, it is not just the amount of potential investment that makes retail investors so desirable, it is also their expected behaviour.

"Retail money is less sensitive to pricing and incredibly sticky, usually staying with investments through good times and bad as long as they generate a good yield," said a senior UK banker.

Another reason for bankers to look favourably on retail participation is that all the downside that used to come from large retail components of shareholder registers has diminished since they were last a major part of UK flotations.

"Fifteen years ago, everything had to be done telephonically, prospectuses had to be printed and sent by post; share certificates had to be printed and dispatched," said Renwick. "Now applications are processed online, shares are dematerialised and held in nominee names, communications are by email and, correspondingly, the costs per shareholder have fallen to less than a tenth of what they were in the 90s."

80s THROWBACK

Before the renaissance of the UK retail investor can begin, however, the government has to settle on a method of distribution. It must choose between the low cost and ease of an intermediary offer, which would be sold through brokers to active and informed investors, and the more expensive full-on retail offer (complete with advertising campaign) that would attract a wider range of UK taxpayers.

Bankers, at least, know which they prefer. They believe that the open offers of the 1980s and 1990s have been made obsolete by the efficiency and economics of intermediary offers, in which brokers specialising in private clients promote the offers to their existing client base.

Nigel Morris of Solid Solutions Associates, which has worked on nearly all the UK retail offers in the past 20 years, said today's retail investor differs significantly from the investor of 20 years ago, and is better served by intermediaries.

"We are living longer and pension schemes are not keeping up. The government and financial advisers are encouraging people to take responsibility for their retirement incomes by managing their own portfolios. The retail investor that participated in public offers hoping to make an overnight return is a thing of the past," Morris said.

Decisions also need to be made on whether to give retail investors special treatment to encourage participation. In the 90s, the UK government used partly-paid offers to retail. But bankers doubt whether today's investors would appreciate the time-value of the discount. Among other things, the partly paid structure makes it essential to ensure a positive aftermarket.

One option favoured by some bankers is to lock in retail by offering bonus shares after one, two or more years of ownership. This could help retail investors to get over the potentially unpalatable aspects of a deal such as RBS, for example, which many investors may feel they have already paid for as a result of the government bailout.

"There could be a perception that the government is asking the public to pay twice for the bailed-out banks. To make this work, investors will have to be incentivised," said the senior banker.

Discounts are the bluntest instrument with which to favour retail, but they encourage flipping.

TELL SID, NOT HUGO

From the government's point of view, intermediary offers could be seen as deepening - but not widening - the shareholder base by selling to investors who already participate in the stock market, rather than reaching all taxpayers.

Bankers question whether there would actually be much difference in outcome between the two options, because an effective marketing campaign could garner mass participation (through the brokers). But such details may be unimportant, because decisions will be ultimately dictated by politics, not by ECM considerations.

A full retail offer will be a mixed bag for the banks running an IPO. The Direct Line offer ran for just 10 days, but a fully blown retail roll-out would take much longer. On the other hand, market risk should be less of an issue. In appealing to retail, the government could not risk pricing the deal too high - and thus setting up the possibility of a negative aftermarket.

In any case, it will need to be careful not to promise too much to investors.

To generate interest when Railtrack was privatised in 1996, the government used partly-paid shares, cash discounts and bonus shares - and an astonishing promised dividend yield of 19% (which was upped during the marketing). Five years later, the government forced Railtrack's nationalisation, unleashing a fierce and chaotic battle to win compensation for shareholders. The current government will seek to minimise any opportunity for comparison with Railtrack.

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